How Outdated Statutes Short-circuit Competitive Markets

Executive Summary

Restructuring and increasing competition in the electricity industry is a reality in over half of U.S. states and the District of Columbia. As the electricity industry becomes more competitive, competition in electric power generation will create more choices for consumers and lead to efficient production of power. To realize these benefits, though, will also involve reconsidering the tax, legal and regulatory treatment of electric cooperatives. Cooperatives are member-owned non-profit private power companies, and they enjoy the following subsidies:

Tax exemption. Cooperatives are exempt from federal corporate income tax, some other federal taxes, and state and local income taxes. Investor-owned utilities are not tax exempt because of their for-profit status, but they can take advantage of investment tax credits and accelerated depreciation, while cooperatives cannot.

Loans. Through the Rural Utilities Service (RUS, successor to the Rural Electrification Administration), electric cooperatives qualify for low-interest insured or guaranteed loans. These loans, in combination with the fact that they cannot pay interest to their members on their shares, mean that cooperatives have a low cost of capital relative to other utilities. These loan policies introduce distortions into commercial credit markets and are likely to decrease the productive efficiency of cooperatives, particularly generation cooperatives.

Federal preference power. Cooperatives receive preferential treatment in purchasing relatively low-cost hydropower from federal generation facilities. Preference power distorts prices among regional markets, and because of taxpayer subsidies to federal generation facilities, means that some regions are receiving subsidies paid for by all taxpayers.

Cooperatives have also changed their business models as they have used these characteristics to their advantage, diversifying into such complementary businesses as natural gas, water and waste water, telecommunications, and cable and satellite television. As the country has evolved demographically, cooperatives have also found that their member base is increasingly suburban instead of rural, and that they can reach out to customers that are not their traditional members. Many cooperatives that used to serve small, rural communities now serve upscale urban developments, yet retain the preferential treatment accorded to them in return for serving small, rural communities. Thus many rural cooperatives are going commercial concerns, not lifeline service to rural areas any longer.

A timely reexamination of these factors would contribute to the growth and success of competition in the electricity industry. Integrating electric cooperatives into the restructuring industry will bring benefits to cooperative members and consumers, but the best way to ensure that those benefits occur is to create consistent tax, legal and regulatory treatment. Markets do not function well when participants play by different rules.

We make a series of policy recommendations for cooperatives to navigate the transition to a competitive electricity industry, and for all consumers to enjoy sovereignty to choose providers and services:

Change the cooperative’s tax exemption, ensuring at least that the income they earn on operations other than selling electricity to members is taxable;

Revise the loan operations and provisions of the RUS so that the loans they make are less risky, the borrowers who are financially able transition to commercial credit, and the agency can return to its mission of improving rural electric and telephone infrastructure; and

Remove federal preference power special treatment for cooperatives, opening access to federal power for all through an auction process.

Attachments

Lynne Kiesling is Director of Economic Policy at Reason Public Policy Institute. She is also Visiting Associate Professor of Economics at Northwestern University. Her previous positions include Assistant Professor of Economics at the College of William and Mary, and Manager in the Transfer Pricing Economics group at PriceWaterhouseCoopers LLP. She has a Ph.D. in economics from Northwestern University, and has published extensively in academic journals.